EAC                                                                

Attractive position in heavy-lift aerial services bolstered by 2013 acquisitions, which reduce seasonality, diversify end markets and introduce new geographies.  Currently trading at steep discount to competitors as well as to the value of its assets, presenting upside of ~54%     

Overview

We recommend Erickson Incorporated (“the Company”, “Erickson”, or “EAC”) as a long.

Erickson is a global provider of specialized aerial services to commercial and government customers.  Established in 1971 by Jack Erickson, the Company is the world’s largest operator of the S-64 Air-crane, a heavy-lift helicopter with 25,000 pounds lift capacity.  Erickson owns the Type and Production Certificates for the Air-crane, granting the Company exclusive design, manufacturing and related rights for the aircraft and original equipment manufacturer ("OEM") components.  In 2013, Erickson made a pair of transformative acquisitions, Evergreen Helicopters and Air Amazonia, which provide access to attractive new end markets and additional helicopter fleets to sell into its legacy customer base. 

Our Erickson investment thesis is based on the following: (1) Established leading position in heavy-lift aerial services; (2) Transformative 2013 acquisitions doubled size of the Company, reduced seasonality and diversified business across end markets, geographies, and (3) Strong financial profile could improve further with realization of deal synergies.

Investment Thesis

1.   Erickson earns recurring revenues under long-term contracts and is an established leader in the global heavy-lift aerial services market, which has significant barriers to entry

Erickson supports commercial and government customers via stable, long-term contracts.  With regards to its government customers, Erickson has already passed rigorous contracting processes and obtained passenger transport certifications.  As customers must factor in lengthy lead times and high costs for switching, Erickson’s contract renewal rate is 95%. 

Erickson’s fleet of 22 Air-cranes is the largest in the world and provide the Company with dominant market share in the global heavy-lift segment.  The Company is a manufacturer and operator of the only commercial heavy-lift helicopter in production with a payload capacity of up to 25,000 pounds and no geographic or category restrictions.  EAC’s leading market position is insulated by its proven safety track record, historical investment in capital and ownership of intangible assets (production certificates, entrenched customer relationships).     

2.   Erickson’s 2013 acquisitions reduce seasonality, diversify customer base across industries and geographies

Erickson’s Air-crane fleet primarily serves commercial customers engaged in aerial firefighting, infrastructure construction and timber harvesting.  Firefighting is by far the largest Air-crane end-market with demand peaking during the summer months of the northern hemisphere.  Therefore, 3Q is the only quarter during which utilization of the Air-crane fleet approaches 100%.  Erickson had mitigated firefighting seasonality by negotiating guaranteed daily standby rates, such that only 30% of revenues was tied to flying hours, and by diverting the fleet to Australia where the firefighting season runs from November to February.  Nevertheless, dependence on firefighting means that the Air-crane business is extremely seasonal and subject to weather conditions (specifically the intensity of summer seasons in northern hemisphere and Australia).    

Erickson’s May 2013 acquisition of Evergreen Helicopters added 63 medium/light-lift aircraft that transport personnel (including United States Department of Defense) in Afghanistan, Iraq, Africa and the Philippines.  The Air Amazonia acquisition in September 2013 was smaller in magnitude (6 medium/light-lift helicopters that support on-shore drilling operations in Brazil), but gave Erickson access to the critical South American market.  Prior to these deals firefighting had accounted for 45% of 2012 revenues, but it became only 22% of 2013 Pro Forma revenues (defense 46%, energy & infrastructure 17%, timber 9%, MRO and other 6%).  The Evergreen and Air Amazonia acquisitions also diversified EAC’s revenues from a geographical perspective. 

Going forward, we believe that that the new Erickson’s end markets will benefit from various cyclical and secular growth drivers

• Firefighting: Domestic demand tied to increasing number of severe fires caused by overgrazing (less grass cover, more woodland) and homes constructed closer to forests.  This segment is also expected to benefit from the 62% wildfire-fighting budget increase proposed by President Obama on July 8, 2014. In addition, the governments of Australia, Canada, Greece and Turkey continue to outsource for firefighting overseas.
• Energy & Infrastructure: EAC has Right of First Refusal for Rosneft / HRT (prior Air Amazonia owner) onshore and offshore drilling in South America, as well as the option to purchase eight additional aircraft.  EAC can also bid opportunistically on work for new oil & gas pipeline projects and exploration activity in inaccessible locations.  In 1Q 2014, EAC announced a deal to support Hunt Oil and Gas in Peru using legacy Air-crane and Evergreen aircraft, illustrating the new Erickson’s abilities to penetrate the South American energy market and cross sell its combined fleet.
• Timber: We anticipate strong growth due to cyclical rebound as well as secular trend towards selective harvesting (vs. clearing).

3.   The “New Erickson” has an attractive financial profile and is positioned to realize cost synergies across expanded fleet

Erickson emerged from the 2013 acquisitions as a larger company (2013 Pro Forma revenues of $395 mm vs. 2012 revenues of $181 mm).  We believe that EAC maintains an attractive financial profile, characterized by 2013 Pro Forma EBITDA margin of 26.6%.  We project that EAC’s relatively low maintenance capital expenditures and net working capital investment will allow it to earn a Return on Net Assets of 17% in 2014. 

In addition, as EAC integrates Evergreen Helicopters and Air Amazonia, there are multiple opportunities for incremental synergies. 

• Utilization of Evergreen fleet across EAC footprint: Historically, Evergreen’s fleet utilization has been constrained by financial challenges at its parent.  Erickson can increase utilization of Evergreen’s fleet by cross-selling within its legacy customer base and optimizing aircraft to mission. 
• Avoidance of penalty fees: EAC has paid penalties when its fleet was not available due to mechanical failures, extreme weather etc.  In the future, the Company should be able to deploy best practices across its combined fleet in order to minimize such penalties (as it has already done in 1Q 2014).
• MRO “insourcing”: The 2013 acquisitions increase the addressable market for Erickson’s manufacturing and maintenance facility in Central Point, Oregon (additional aircraft types).  In addition, ERC can reduce MRO costs by performing more services in house ($8mm of MRO cost synergies already identified).
• Reduction of aircraft lease payments: Evergreen leased a majority of its aircraft which results in higher operating costs.  Erickson can opportunistically use its balance sheet to bring the Evergreen fleet in-house. 
• Marketing and SG&A initiatives.

Valuation and Price Target

We believe that Erickson is significantly undervalued at its current share price.    As shown in Exhibit 1, EAC is currently trading at a TEV / LTM EBITDA multiple of 6.4x compared to aerial services peer average of 8.7x.  We believe this discount is unwarranted given the Company’s ability to earn higher EBITDA margins (26.6% on an LTM basis compared to peer average of 22.1%) and dominant position in the heavy-lift segment (many of Erickson’s peers are in the more competitive offshore oil & gas segment).  If Erickson were to trade up to the average EBITDA multiple of its peers, its enterprise value would increase to ~$916mm and equity value to ~$463mm, or $33.26 per share, 110% upside to the July 7, 2014 closing price . 

Exhibit 1 also shows that Erickson is trading at a TEV / Value of Owned Fleet multiple of 1.0x compared to aerial services average of 2.2x and median of 1.5x (excludes 6.4x outlier for Air Methods).  Due to the capital intensive nature of the aerial services industry and the liquidity of its fleet, we believe that Erickson should trade at no less than the value of its assets.  In Exhibit 2, we assign a value to each aircraft owned by Erickson to arrive at a value of $646mm for its owned fleet.  In Exhibit 3, we use this value of EAC’s owned fleet to calculate an asset value per share of $24.34, 54% upside to the July 7, 2014 closing price. 

Risks & Mitigants

Afghanistan represents approximately 20% of 2014E revenue; expected US troop removal could have impact

Barring a complete withdrawal from Afghanistan by the U.S. DoD due to an Afghan failure to sign the Bilateral Security Agreement, we believe that the Company’s Afghanistan revenue will decrease gradually over the next two years. Our industry checks indicate that Evergreen currently has nine aircraft deployed in Afghanistan. Of these nine aircraft, three are fixed-wing aircraft subcontracted to Dyncorp that will remain in Afghanistan as part of long-term stability operations as long as the U.S. DoD maintains any sort of presence in Afghanistan. The remaining six aircraft are subcontracted to Fluor and are used for travel between the three major military bases in Afghanistan: Kabul, Bagram, and Kandahar. July marks the renewal period for this contract, and our industry sources expect that Fluor will keep all six aircraft until next year after which Fluor may begin to descope the contract. We believe that the Company will offset Afghanistan revenue declines with contract wins in Africa (AFRICOM) and by redeploying aircraft to both Air Amazonia and Erickson’s existing customer base. 

Historically the Company has large cyclical exposure to timber harvesting; cyclical downturn could hurt

As a result of the Evergreen and Air Amazonia acquisitions, the Company is now well diversified by end market and by geography.  In addition, timber harvesting is rebounding from generational lows so this end-market would seem (to us) to present more upside than downside.

Shareholder litigation relating to Centre Lane Partners involvement in Evergreen Aviation (the distressed seller and former parent of Evergreen Helicopter)

Evergreen Helicopter was bought by EAC through an auction run by Goldman Sachs.  Given the nature of the auction process, the shareholder litigation alleging a “bailing out” of Evergreen Aviation by EAC would appear to lack merit.  Liability, if any exists, would also appear more likely to relate to Centre Lane Partners as opposed to the Company. 

Exhibit 1: Trading Comps ($ in millions)